by Calculated Risk on 10/15/2007 07:04:00 PM

From Fed Chairman Ben Bernanke: The Recent Financial Turmoil and its Economic and Policy Consequences. A few excerpts:

... despite a few encouraging signs, conditions in mortgage markets remain difficult. The markets for securitized nonprime (that is, subprime and so-called alt-A) loans are showing little activity, securitizations of prime jumbo mortgages reportedly have increased only slightly from low levels, and the spread between the interest rates on nonconforming and conforming mortgages remains elevated. These continued problems suggest that investors will need more time to gather information and reevaluate risks before they are willing to reenter these markets.
...
Since the September meeting, the incoming data have borne out the Committee's expectations of further weakening in the housing market, as sales have fallen further and new residential construction has continued to decline rapidly. The further contraction in housing is likely to be a significant drag on growth in the current quarter and through early next year. However, it remains too early to assess the extent to which household and business spending will be affected by the weakness in housing and the tightening in credit conditions. We will be following indicators of household and business spending closely as we update our outlook for near-term growth. The evolution of employment and labor income also will bear watching, as gains in real income support consumer spending even if the weakness in house prices adversely affects homeowners' equity. The labor market has shown some signs of cooling, but these are quite tentative so far, and real income is still growing at a solid pace.

On the inflation side, prices of crude oil and other commodities have increased somewhat in recent weeks, and the foreign exchange value of the dollar has weakened. However, overall, the limited data that we have received since the September FOMC meeting are consistent with continued moderate increases in consumer prices. As the Committee noted in its post-meeting statement, we will continue to monitor inflation developments carefully.

It does seem that, together with our earlier actions to enhance liquidity, the September policy action has served to reduce some of the pressure in financial markets, although considerable strains remain. From the perspective of the near-term economic outlook, the improved functioning of financial markets is a positive development in that it increases the likelihood of achieving moderate growth with price stability. However, in such situations, one must also take seriously the possibility that policy actions that have the effect of reducing stress in financial markets may also promote excessive risk-taking and thus increase the probability of future crises. As I indicated in earlier remarks, it is not the responsibility of the Federal Reserve--nor would it be appropriate--to protect lenders and investors from the consequences of their financial decisions. But developments in financial markets can have broad economic effects felt by many outside the markets, and the Federal Reserve must take those effects into account when determining policy. In particular, as I have emphasized, the Federal Reserve has a mandate from the Congress to promote maximum employment and stable prices, and its monetary policy actions will be chosen so as to best meet that mandate.

Indeed, although the Federal Reserve can seek to provide a more stable economic background that will benefit both investors and non-investors, the truth is that it can hardly insulate investors from risk, even if it wished to do so. Developments over the past few months reinforce this point. Those who made bad investment decisions lost money. In particular, investors in subprime mortgages have sustained significant losses, and many of the mortgage companies that made those loans have failed. Moreover, market participants are learning and adjusting--for example, by insisting on better mortgage underwriting and by performing better due diligence on structured credit products. Rather than becoming more crisis-prone, the financial system is likely to emerge from this episode healthier and more stable than before.

by Calculated Risk on 10/15/2007 05:48:00 PM

U.S. Subprime Classes Issued During First Three Quarters Of 2005 Affected By Oct. 15, 2007, Rating Actions (hat tip Brian)

From Reuters: S&P cuts $4.6 bln of subprime mortgage backed assets (hat tip FFDIC)

Standard & Poor's on Monday cut its ratings on $4.6 billion worth of residential mortgage-backed securities exposed to subprime mortgages, citing expectations of further defaults and losses in the securities.

The downgrades include 402 pieces of 138 transactions. All are backed by first-lien subprime mortgage loans issued in the first three quarters of 2005.

The majority of the ratings cuts were in the "BBB" category, which is the lowest tier of investment grade.

"These rating actions incorporate our most recent economic assumptions, and reflect our expectation of further defaults and losses on the underlying mortgage loans and the consequent reduction of credit support from current and projected losses," S&P said in a statement.

by Calculated Risk on 10/15/2007 03:07:00 PM

Click on graph for larger image.

From barchart.com.

This chart tells the what. The question is why?

From MarketWatch: Oil futures probing uncharted territory

Crude-oil futures advanced Monday into uncharted territory ... as the market continued to take momentum from supply concerns due to risks to production in the Middle East and declines in U.S. crude inventories.

by Calculated Risk on 10/15/2007 11:09:00 AM

From the WSJ: Nomura to Close U.S. Mortgage Business

Nomura said it would take a loss of $621 million on write-downs of residential mortgages and an additional charge of about $85 million for restructuring the business. That will swing Nomura to a pretax loss of as much as $510 million in the quarter ended Sept. 30, 2007. In the same quarter a year earlier, Nomura posted a net profit of about $2.1 billion.

"This is an extremely regrettable result," said Nobuyuki Koga, Nomura's president and chief executive officer.

It appears Nomura wrote down more than they made from the mortgage business in earlier periods:

... the $620 million Nomura has written off on subprime loans dwarfs the estimated $108 million in revenue it generated on residential mortgage-bond underwriting between 2002 and 2006, according to Dealogic.

Regrettable indeed.

by Anonymous on 10/15/2007 08:44:00 AM

Yves at naked capitalism has a post up this morning on the Citicorp-Related Asset Conduit Kerfuffle (MLEC), which I recommend.

There's also this charming bit from this morning's New York Times:

The problems raised alarms immediately in Washington, because commercial paper is a critical financial pillar for the economy, helping to provide money for home loans, credit cards and airplane leases. At the Treasury, Robert Steel, deputy under secretary for domestic finance, and Anthony Ryan, assistant secretary for financial markets, called top executives from about 30 banks to a meeting in Washington after realizing that the banks were not talking to one another about the crisis, people familiar with the talks said.

As a long-time observer of the banking industry, allow me to observe that one of our major problems has always been that we don't talk to anybody except each other. Trust a reporter to publish talking points about "pillars of the economy" and the Treasury just doin' a little healthy fostering of interbank communication skills.

From where I sit, it seems like a lot of investors no longer want to be the bagholder of the "pillars" of this economy, thanks. And Citicorp doesn't want to honor the guarantees it made to those SIVs in the first place, either. So instead of letting Citi take the consequences of having provided financial backstops to these things, the Treasury department thinks its a good idea to just "square" them (hey! it worked so well with CDOs!).

by Calculated Risk on 10/14/2007 08:48:00 PM

From The Atlanta Journal-Constitution: Housing slump affects sales tax collections

Georgia's tax collections fell slightly last month, following a trend across the country where the housing slump has begun to affect state budgets and sparked talk of spending cuts for education and health care.

Collections in Georgia were down $2.3 million in September, compared to the same period in 2006. Sales taxes dropped 10.6 percent. For the first quarter of the fiscal year, which began July 1, overall collections are up 5 percent, or $199 million. The state needs a growth rate of 5 percent or more for the rest of fiscal 2008 to meet its $20.2 billion budget.

Income tax collections rose 5.1 percent last month. However, sales tax collections - which are tied to consumer spending - faltered, dropping $47.6 million over September 2006.

"A big chunk of that is related to the housing downturn," said Kenneth Heaghney, the state's fiscal economist. "The lumber sector is down, building materials are down, and the home furnishing sector is down. That seems to be taking a chunk out of .... the sales tax numbers."

by Calculated Risk on 10/14/2007 07:16:00 PM

From Reuters: Global defaults to reach 4.5-5.5 pct by 08-Barclays

Tighter bank lending standards and slowing economic growth could push global speculative-grade default rates as high as 5.5 percent by mid-2008, up from 1.48 percent currently, Barclays Capital said on Friday.

"When you do get a tightening of lending standards, you do certainly get a slowdown in the economy and that in turn starts to put pressure on corporates (corporate bonds)," Robert McAdie, Barclays Capital's global head of credit strategy, said on a Barclay's conference call.

If tight bank lending conditions persist, the default rate in the United States will likely rise to 6.9 percent from 1.5 percent currently, and in Europe to 7.75 percent, up from 2.9 percent, McAdie said. The global rate will likely reach 4.5 to 5.5 percent, he said.

Click on graph for larger image.

To put these numbers into perspective, this graph shows the U.S. speculative grade default rates from 1990 through 2005. The rate fell even lower in 2006 and is currently around 1.3 percent.

Others see the default rate staying near record low levels:

"Barring an outright recession, we do not expect a material rise in the default rate over 2008," said Daniel Lamy, a credit strategist at JP Morgan, in a note to clients. "We could be looking at defaults in the region of 1.5 percent again next year."

For the housing market, defaults were very low for several years as homeowners in trouble could either sell their homes or refinance at a lower rate. The same has been true for companies in trouble. But now, with rising rates for speculative grade bonds, it will become more difficult for these companies to obtain additional financing, and the default rate will probably rise.

by Calculated Risk on 10/14/2007 12:54:00 PM

According to CNBC: Surprise! Americans Set to Open Wallets This Holiday

It’s going to be a joyful—and profitable—holiday season for retailers, according to the surprising findings of the latest CNBC Wealth in America survey.

Americans plan to spend an average $839 during the holiday season, up 17.6% from last year, the survey says.
...
As the Dow closed Friday above 14,000, it is noteworthy that more than half of Americans surveyed believe a recurrence of the 1987 stock market crash, the anniversary of which is this Friday, is unlikely and about half of Americans believe now is a good time to buy stocks.
...
Much of the economic news in the past few months has focused on the housing industry and, according to CNBC’s survey, an overwhelming 90% of American home owners expect their home process [prices?] to stay the same or increase over the next 12 months by an average of 3.9%. And, nearly 80% of Americans said they don’t increase their spending based on gains in the price of either their homes or stock portfolios.

Meanwhile, in other news, most Americans eat healthy, excercise regularly, 'all the women are strong, all the men are good looking, and all the children are above average'. (from Garrison Keillor) emphasis added

Sorry, this is just too funny.

by Calculated Risk on 10/13/2007 04:31:00 PM

From the NY Times: Banks May Pool Billions to Avert Securities Sell-off

... Citigroup, Bank of America and JPMorgan Chase, along with several other financial institutions, have been meeting to come up with a plan to create a fund that could prevent a sharp sell-off in securities owned by bank-affiliated investment vehicles. The meetings, which began three weeks ago, have been orchestrated by senior officials at the Treasury Department, and the discussions have intensified in the last few days.

A broad framework for an agreement could be reached as early as tomorrow ... but many important details still need to be hammered out. Another round of discussions is taking place this weekend, and it still possible that the parties will not reach agreement.

See the article for a few more details. Here is the Reuters take: Treasury officials seek to help battered SIVs

One plan that was discussed at the meeting involved setting up a "super fund" where "each SIV in the market could pledge up to one-third of its assets and get financing," the source said.

The WSJ reported on this last night: Big Banks Push $100 Billion Plan To Avert Crunch

If the banks agree, the plan could be announced as early as Monday, people familiar with the matter said. Citigroup announces third-quarter earnings Monday. The tentative name for the fund is Master-Liquidity Enhancement Conduit, or M-LEC.

by Anonymous on 10/13/2007 12:51:00 PM

In an attempt to keep my mind off of M-LEC, I decided to don a Hazmat suit and go see what those mortgage professionals over at Broker Universe are up to these days. I feel obligated to share this with you.

This is just a beaut:

Who can do Seller Carry Back Loans ?

In August 2005, husband and wife purchase a condo in San Mateo County, CA. for $400,000., and got 100% financing.

They did not occupy the condo, the wife’s brother moved in and he has been paying the mortgage, taxes, and HOA fees from the beginning.

The condo now has an appraised value of $460,000.

The total mortgage balance owed on the condo is $399,000.

The husband and wife would like to sell condo to the wife’s brother.

Can sellers do a 10% carry back, and let the buyer get a 90% purchase loan ?

Loan amount would be $414,000.

Who will do the 90% purchase loan ?

The good news is that, so far, no lender representative has responded to this offering to get screwed. The bad news is that, so far, no lender representative has asked for the broker's real name and state so that the lender can make sure this character is on all "debarred" lists.

The thing I really like about this scenario is that, while the odds are very good that parts of it are untrue, it's even worse if you assume it's all true. I mean, it's probably just some run-of-the-mill liar with a fake appraisal wanting to get out of a bad "investment." But imagine if it were true: there's a couple out there who "bought" a condo without risking any of their own money in down payment. They managed to sucker the brother into carrying the mortgage and all other ownership expenses. Now that they at least believe that the unit has appreciated by 15% in two years or so, they would like to extract that appreciation from their own relative by having him in essence assume their mortgage to get them out of any liability, plus pay them $15,000 out of loan proceeds, plus sign a note requiring him to pay them the balance of the "appreciation" over some period of years, with interest.

In Broker America, this is apparently considered a perfectly legitimate transaction.